There’s a sucker born every minute. Whether P.T. Barnum himself actually uttered those words in the 19th century is immaterial. While vast technological changes occurred from the 19th to the early 21st century, human nature is much the same. There’s always someone looking to get rich quick, and always someone eager to part a fool from his money. Penny stock trading attracts both types.
Yes, every once in a while someone makes a killing in penny stocks. Someone also wins the lottery, but that doesn’t mean buying lottery tickets is a wise investment strategy. Overall, penny stocks are a loser’s game, and the occasional player who cleans up is the exception, not the rule.
Penny stocks – also known as micro cap or nano cap stocks – are cheap. If you’re familiar with large cap, mid cap and small cap companies, you know these terms refer to market capitalizations of:
- $10 billion and up for large caps
- $2 to $10 billion for mid caps
- $300 million to $2 billion for small caps.Micro cap stocks have market capitalizations of less than $300 million, while a nano stock’s cap is less than $50 million. That might sound like a great deal of money, but it isn’t in the market capitalization scheme of things. These companies are often quite volatile.
Micro cap or nano cap stock shares may cost more than pennies, but each share is less than $5.00. These stocks don’t trade on major exchanges, and aren’t regulated by the Securities and Exchange Commission. They are traded on an “over-the-counter” market because there is so little regulation and no minimum requirements. No financial analyst evaluates them. Penny stocks trade on “pink sheets,” daily publications put out by the National Quotation Bureau. These pages got their name because they were literally printed on pink paper.
“Pump and dump” is a favorite scheme of penny stock fraudsters. A promoter claims to possess inside info about a particular stock, and posts that info in chat rooms and micro cap stock forums. E-mail spam touting the stock is another favorite ploy. Once the suckers – ah, investors – take the bait, purchase the stock and drive the price up, the crooks sell. They’ve made money pumping – or hyping – and dumping, and their victims lose it all.
Not every penny stock is a fraud. There are diamonds in the rough in the penny stock market, but finding them is tough. Your best bet – emphasis on bet- is on a well-known foreign stock listed on the pink sheets. They trade there because the company meets all regulations in their country of origin, but they do not want to go through the considerable expense of hiring legal and regulatory staff with U.S. securities law expertise.
As an investor, it’s your responsibility to perform your own due diligence when purchasing individual stocks. With many penny stocks, that’s almost impossible. These companies don’t file annual reports on time, or at all. That means there’s no way for you to determine a company’s earnings, or have a clue about its business model. You may not be able to discover its track record because it doesn’t have one.
Penny stock prices fluctuate wildly. That’s what draws gamblers in. A penny stock price can shoot up from 10 cents a share to 50 cents a share in one week. Think of the money you could make! There’s just one problem. You could try to sell those shares through your brokerage account with absolutely no action. It’s not an uncommon scenario with penny stocks. The sell order could languish for days with no interest, and meanwhile the stock price plummets. Lack of liquidity haunts the penny stock market.
If you decide to put some money in penny stocks, treat it as gambling. Your odds are probably better at the racetrack or casinos, but people have different ways of having fun. Just don’t think of what you’re doing as investing and, like gambling, don’t use money you can’t afford to lose.
If you don’t have a lot of money to invest, there are far better alternatives than penny stocks. Purchase shares in a plain vanilla, low-cost mutual stock index fund. It’s not exciting, but over time, by making regular investments and reinvesting dividends, you’ll make money. It’s called getting rich slowly.
Regards,
Ethan Warrick
